Will Reinsurance Rebound from Terrorist Strikes in the U.S.’

If the nautical term best applied to the reinsurance industry last year at this time would have been “steady as she goes,” after the catastrophe that struck the U.S. on Sept. 11, the French term “sauve qui peut” might better describe its present condition. That phrase can be interpreted as both “abandon ship,” and “every man for himself,” and sums up the initial reaction to this tragedy, at least in respect to the financial challenges faced by the industry. The hard part comes now, coping with the losses—emotional, personal and financial—and healing an industry that has been forever changed by the catastrophe.

Full year statistics have lost their meaning and most forecasts are out the window, but a few certainties are apparent. The costs to the insurance industry of covering the losses wrought by the terrorist attacks will be huge. Large well-capitalized companies will nevertheless survive, and ultimately grow stronger. Some smaller and mid-sized insurers and reinsurers will have problems; some of them will disappear. The industry will have to make greater efforts to tighten up underwriting standards, rates will rise and some perils will become uninsurable in the private sector at any price.

The U.S. disasters are an event that is unique outside of wartime. The reinsurance industry will therefore face a new situation. Longtime reinsurance consultant Paul Walther, who heads Reinsurance Directions Inc., remarked, “The World Trade Center disaster hit everybody, even the life companies weren’t immune, all the lines were affected.” In that sense it’s unlike hurricanes or earthquakes, which usually hit property insurers, or air crashes which affect mainly aviation insurers. No sector of the industry remained untouched.

According to the people he’s been in contact with, the reinsurance industry is still in some disarry, Walther said. “It needs to cope with the personal losses as well as the financial losses. It seems that almost everybody knew someone who’s missing.” Trying to deal with those issues, while being under pressure to start paying claims, has put a burden on the industry unlike any it has ever experienced.

Ironically the attacks came in the middle of the “Reinsurance Rendezvous” in Monte Carlo, and quickly swept aside all other planned discussion topics. Many participants, notably Aon and MarshMac’s Guy Carpenter had offices in the World Trade Center.

Just the day before, London’s Financial Times had published a survey of the industry that contained some encouraging news, but also warned of deteriorating results. While there was a decrease in capacity generally, leading to raises in premiums, the study also noted that those who supply the capital are becoming increasingly more demanding for greater returns on their investments. They will look even harder after Sept. 11.

Another conclusion the FT noted was an improvement in pricing relative to risks. That conclusion too has been compromised by the WTC disaster. Another phase of the study saw improvement in the Lloyd’s market with break even being reached this year. No one is predicting that now.

Long and short-term consequences: challenges to be met
The challenges facing the reinsurance industry are the same ones it faced before the attacks, but the changed circumstances make it imperative that it meet them. “It’s going to require quite a lengthy recovery period,” Walther observed, “but they need to begin satisfying their claims payment obligations, now.”

The most visible aspect of the tragedy is the loss estimates. In the few days after the attacks many reinsurers made preliminary estimates, knowing that they’d have to increase them as more definitive figures were obtained. A few of the latest: Munich Re (American Re)–$1.94 billion; Swiss Re–$1.25 billion; Berkshire Hathaway (General & Cologne Re)–$2.2 billion; Employers Re (GE Capital)–$600 million; Hannover Re–$365 million; Partner Re–$350 to $400 million; and Lloyd’s just released its figures estimating losses at around $1.91 billion. There are dozens more, and the true total is still unknown. Some estimates have put the overall losses as high as $70 billion.

As Walther indicated, the claims and losses are coming from all sources. Property and casualty leads the way, but large proportions of the losses in this sector aren’t from direct property damage, but from business interruption claims, to what extent is still largely unknown. Some estimates put aviation losses at up to $6 billion, if each of the four hijackings is treated as a separate event, and no legislation is put in force to limit claims. Workers’ compensation for the more than 6,000 victims in the WTC alone will add several billions, as will the payments by life insurance companies, particularly on “key man” policies.

Reinsurers have set their estimates high in recognition of the extent of the losses. While some Lloyd’s syndicates gave their own estimates, it took Lloyd’s over two weeks to put together overall figures. As it writes around 23 percent of the world’s commercial aviation coverage, and since approximately 40 percent of its business is in reinsurance, Lloyd’s losses will be substantial, perhaps more than the initial estimate.

There are both long-term and short-term consequences for the reinsurance industry. The immediate focus is on liquidity. Companies will have to come up with the amounts necessary to pay claims. This shouldn’t be a problem for industry giants, but it may affect smaller companies in a manner disproportionate to their actual losses. If a company doesn’t have enough cash on hand or liquid investments to pay claims, they have two immediate and equally unpalatable alternatives. They can borrow the money, thereby increasing their debt load, or sell non-liquid assets.

Cashing in assets to pay clams, especially in a depressed market, decreases insurers’ capacity and thus affects their ability to write new business or renew policies; therefore, even as rates increase, some companies may not be able to take advantage of them. Increasing the debt load has the same effect, as most of it is secured, and the lenders, not the policyholders, have first claim on it.

“There’ll be a shakeout,” Walther said. “I’m concerned that a great number of small players in the market will disappear.” On the other hand he’s sure that the larger companies, the ones who weather the storm, will gain even more market share, and will be able to profit from the inevitable premium increases.

He also indicated that part of the problem isn’t just the need for liquidity, but is more structural in nature. “There are many companies that have reinsurance departments, but it isn’t their core business. When they see that they have maybe $1 million in primary exposure, and something like $35 million in reinsurance losses, they’re going to look around and ask themselves ‘should we be doing this?'”

The rhetorical answer is “no,” and a number of smaller players will simply pay their losses and get out. This in turn gives even more leverage to bigger companies, and may make it harder for anyone else to enter the market. “Will it be open to any new players? Will there be sufficient market share to support them?” Walther has his doubts.

Ratings matter
Another difficulty faced by smaller insurers, and even some larger ones, are the actions taken by the rating agencies–Standard & Poor’s, A.M. Best, Fitch, and to some extent Moody’s Investors Service. Just putting a company on credit watch negative increases its cost of borrowing. That cost increases again if the company is downgraded. “AAA” companies don’t have to worry, but S&P has already downgraded Lloyd’s from “A+” to “A” and Zurich from “AA+/Neg” to “AA” and has 18 other insurers on CreditWatch including Hannover Re, Partner Re, PXRE, SCOR, XL Capital, ACE Ltd. and Trenwick Group.

A.M. Best has downgraded Lloyd’s, Trenwick Group, QBE and Copenhagen Re, and is reviewing other insurers. Fitch downgraded Lloyd’s two places from “A+” to “A-“. It currently has ten more companies on its Rating Watch Negative list, including ACE, SCOR, XL, and, surprisingly, Swiss Re. In each case Fitch indicated the primary reason for its action was that their current loss estimates “reflect a material percentage of their capital.”

To rebuild that capital, which all companies large and small will need to do in the wake of the WTC disaster, a company can either go to the capital markets and offer shares, or hope that diminished losses and increased premiums will rebuild it over time.

Given the current state of the capital markets for insurance company shares in general, and reinsurance company shares in particular, this avenue is an unlikely one in the near term. Swiss Re has already indicated that it will probably delay or cancel the $2 billion share offering it had intended to make to fund its purchase of Lincoln National’s reinsurance business.

A need for fundamental reassessment
Companies choosing not to sell out to someone else will need to retrench. Munich Re, in its statement increasing its lost estimates, said: “Munich Re expects a fundamental reassessment of the risk situation for the renewal of reinsurance treaties that traditionally take place in the last quarter of the year, as the attacks have revealed a previously unimaginable risk potential. This not only affects the U.S. market but also applies worldwide. Primary insurance coverage, as well as terms and conditions will have to be completely rethought.”

The key phrase is “fundamental reassessment,” and it implies more than just rethinking policy limits and the perils covered. The loss estimates are astronomic not only because the damages are huge, but because the policies cover such a broad range of perils, that weren’t previously considered as potential catastrophe risks. Chief among these is business interruption coverage (see article on page XX).

And business interruption coverage is open-ended. Given the scope of the WTC tragedy, many primary insurers will end up paying the limits of the policy, which can be quite high. Eventually the reinsurers are going to be asked to reimburse their parts of these payments. Even Munich and Swiss Re admit that they can’t accurately calculate what those losses might eventually add up to. Walther sees a fundamental problem between the primary insurers’ decision to pay policy limits, and the strictures in most reinsurance treaties that are going to be “at odds with any such decision.” Not only will such disputes delay recoveries, but they will also increase costs if they have to be litigated.

He also saw complications from the “spiral effect,” which he described as the problem that arises from multiple retrocessions of coverage to different reinsurers. Each retrocessionaire essentially thinks he has mitigated his risk by ceding a percentage of coverage to another carrier, who then repeats the process. “In far too many cases, and despite the precautions in place, the loss can come back to the cedants, creating horrendous problems in straightening out who pays and producing loss figures that are several times what’s actually covered.” Lloyd’s syndicates, which write both primary and secondary insurance, and frequently cede large portions of their exposures to other syndicates, have a particular problem in this regard.

A fundamental reassessment must also include a review of underwriting procedures. “Do reinsurance underwriters really know what they’re doing?” asked Walther. He pointed out that Renaissance Re apparently has little or no exposure from the catastrophic events in the U.S. Were they just lucky? Or are they doing something better than the others?

One thing Ren Re does very well is make money. Its return on equity in 2000 was 20 percent; another thing it apparently does very well is manage risks by employing modeling systems that it has developed itself.

The necessity to show senior managers and investors that reinsurance underwriters know what they’re doing directly affects a company’s ability to raise capital, and by definition increases its capacity. “They’re really going to need to convince people on this,” said Walther. This is especially true when other investments are available. The reinsurance market, especially Lloyd’s, will now be measured by its ability to produce returns commensurate with competing investment opportunities. Walther thinks it’s possible that a lot of the corporate capital that has flowed into Lloyd’s may “decide to leave.” Should capital providers take their funds elsewhere, it would severely strain not only Lloyd’s, but the entire reinsurance system at a time when it appears to be particularly vulnerable.

“Don’t forget,” Walther added, “this is the first real calamity to hit this year.” One can only hope that after the cruel assaults by one set of misguided human beings on another, that nature will be more benign, and that the reinsurance market will be given the time it needs to recover from both its personal and financial losses.

Topics Catastrophe USA Natural Disasters Carriers Profit Loss Excess Surplus Reinsurance Market Lloyd's